Research on Small Businesses

by Moya K. Mason

1. In the plethora of data released by Statistics Canada each year, two numbers loom that are of particular importance to small business people:
about 145,000 new businesses start up each year in this country, and
about 137,000 businesses declare bankruptcy each year.
It isn't hard to do the math; the ratio is almost one failure for each startup, and it begs the question: "How is it possible that entrepreneurship has so many casualties both in terms of money lost and lives often horribly upset?"http://www.canadaone.com/ezine/sept99/business_success.html

2. The Small Business Administration (SBA) keeps the stats on business failures and claims that more than half of new businesses will disappear in the first five years.

3. Statistics show that 8 out of 10 new businesses fail within the first three years.

4. A study done by Inc. magazine and the National Business Incubator Association (NBIA) revealed that 80 percent of new businesses fail within the first five years.

7. According to Dun & Bradstreet reports, "Businesses with fewer than 20 employees have only a 37% chance of surviving four years (of business) and only a 9% chance of surviving 10 years." Restaurants only have a 20% chance of surviving 2 years. Of these failed business, only 10% of them close involuntarily due to bankruptcy and the remaining 90% close because the business was not successful, did not provide the level of income desired or was too much work for their efforts. The old adage, "People don't plan to fail, they fail to plan" certainly holds true when it comes to small business success. The failure rate for new businesses seems to be around 70% to 80% in the first year and only about half of those who survive the first year will remain in business the next five years.

8. How many small businesses are there?
In 2003, there were approximately 23.7 million businesses in the United States, according to Office of Advocacy estimates. The Internal Revenue Service (IRS) estimates there were 27.0 million nonfarm business tax returns in 2003; however, this number may overestimate the number of firms, as one business can operate more than one taxable entity. IRS estimates the number of sole proprietorships (roughly equivalent to nonemployers) increased 2.4 percent in 2002 and is expected to increase 1.9 percent in 2003. Census data show there were 5.7 million firms with employees and 17.0 million without employees in 2001. Applying the sole proprietorship growth rates to the nonemployer figures and similar Department of Labor growth rates to the employer figures produces the 23.7 million figure. Small firms with less than 500 employees represent 99.7 percent of the 23.7 million businesses.

How many businesses open and close each year?
Estimates for businesses with employees indicate there were 572,900 new firms and 554,800 closures (both about 10 percent of the total) in 2003. http://www.sba.gov/ADVO/stats/sbfaq.txt

9. What is the survival rate for new firms? Two-thirds of new employer firms survive at least two years, and about half survive at least four. Owners of about one-third of firms that closed said their firm was successful at closure. Major factors in a firm's remaining open include an ample supply of capital, the fact that a firm is large enough to have employees, the owner's education level, and the owner's reason for starting the firm in the first place, such as freedom for family life or wanting to be one's own boss. Business survival also varies by industry and demographics. The industry with the highest 1992-1996 survival rate for firms owned by white non-Hispanics was oil and gas extraction (82 percent survival rate over the four-year period). African Americans were most successful in legal services (79 percent), and Hispanic and Asian Americans in health services (66 percent and 76 percent, respectively). Sources: Business Success: Factors Leading to Surviving and Closing Successfully by Brian Headd, Center for Economic Studies, U.S. Bureau of the Census, Working Paper #CES-WP-01-01, January 2001; Advocacy-funded research by Richard J. Boden (Research Summary #204).

10. The developing countries of Asia and Latin America are far ahead of Europe in starting new businesses, according to a recent survey of global entrepreneurial activity. But few start-ups have the potential to make an impact on jobs and growth, and a negligible number benefit from venture capital, with the vast majority reliant on informal funding. The 2002 annual survey by the Global Entrepreneurship Monitor (GEM) was carried out across 37 countries representing 92% of world GDP. It finds that 286 million people, 12% of the workforce in these countries, are engaged in starting or running a new business, implying a global figure of about 460 million. "We were quite shocked by how high the index is in the developing countries," admits Paul Reynolds, the GEM project co-ordinator. "Only now do we have a fuller understanding that half of the people in many developing countries are doing it out of necessity because they cannot find work, and that is what drives the rate up so high."

The distinction between people who are voluntarily pursuing an attractive business opportunity (opportunity entrepreneurs) and those who are doing it because they have no other source of income (necessity entrepreneurs) is key to understanding many, although not all, of the national differences. As one might expect, the number of necessity entrepreneurs is smallest in countries with developed welfare systems.

11. The report also looks at factors affecting business closure. Here, the lack of robust data hampers a comprehensive analysis. The few studies available reveal that not all businesses close owing to financial failure. Many one-person businesses close because the owner has decided to take advantage of a better job opportunity. The authors conclude that it might be more appropriate to talk about business "disappearance" than failure. This might help to reduce the stigma Europeans attach to business closures, a stigma which often deters potential entrepreneurs from taking the plunge. Perhaps they need to take a leaf out of the book of American business owners who tend to view bankruptcy not as a failure but just another experience from which to learn.

12. Every year, 470,000 new businesses open in Brazil, but 43 percent will close their doors before their third anniversary. Half of all small businesses in Brazil close their doors in the first two years of operation. That, says Silvano Gianni, head of the Sebrae (Serviço Brasileiro de Apoio às Micro e Pequenas Empresas-Small Business Administration), is one of the highest business mortality rates in the world.

The survey showed that out of 1.3 million new businesses opened between 2000 and 2002, a total of 552,700 of them closed down before they were three years old, with the vast majority (49 percent) closing before they reached two years of operation. The remaining 772,600 generated 2.4 million jobs and investments totaling US$ 6.5 billion (19.8 billion reais).http://www.brazzil.com/2004/html/articles/aug04/p121aug04.htm

14. A Small Business Administration study earlier this year found that 24 percent of new businesses never make it to their second anniversary. Another 23 percent fail in the next two years. Some high-risk ventures, such as restaurants, have a two-year attrition rate as high as 80 percent. In 2002, an estimated 550,100 new businesses were established in the U.S., according to the SBA, while an estimated 584,000 closed their doors for good.

15. But SMEs have their special challenges and are also more vulnerable than large companies. Though business publications report the surge of more and more SMEs, in the U.S. the rate of failure for new businesses is 50%.http://www.sics.se/fid/conf/asis98/conn.html

16. The average failure rate of foreign firms in the U.S. is about 9.4 per 10,000 firms, while the domestic failure rate is 81. In manufacturing, the FFR is also lower than the DFR for the 1978-88 period. The average failure rate of foreign manufacturing firms is 22, whereas the average failure rate of U.S. manufacturing firms is 85.http://www.bls.gov/opub/mlr/2000/07/art1full.pdf

17. According to Dun & Bradstreet reports, "Businesses with fewer than 20 employees have only a 37% chance of surviving four years (of business) and only a 9% chance of surviving 10 years." Restaurants only have a 20% chance of surviving 2 years. Of these failed business, only 10% of them close involuntarily due to bankruptcy and the remaining 90% close because the business was not successful, did not provide the level of income desired or was too much work for their efforts. The old adage, "People don't plan to fail, they fail to plan" certainly holds true when it comes to small business success. The failure rate for new businesses seems to be around 70% to 80% in the first year and only about half of those who survive the first year will remain in business the next five years. During the first half on 1997, over 43,000 U.S. businesses failed. This failure rate was up 13% from the first six months of 1996. Dollar liabilities from business failures totaled over $20 billion, 40% over the same time period of the previous year.http://cpa.utk.edu/pdffiles/adc24.pdf

18. In the first year nearly one third of all start ups failed on the average. The proportion of failures then declined for each subsequent year but the cumulative failure rates are high - 62% after 3 years and 74% after 5 years. In other words, no more than about one quarter of enterprises have survived five years. There have been criticisms of the Williams study (Haswell and Holmes 1989), but research conducted in the US has reported similar results (Churchill 1952; Star and Massel 1981) and high failure rates have been reported in the UK (Hill 1987; Storey et. al 1987; Keeble 1990).

There is a high failure rate of small business in Australia although there are various meanings of "failure" and disagreement on the actual rate. Even though resource poverty affects all small businesses in differing degrees, the root cause of failure is management inefficiency and particularly inefficient financial management and poor accounting.http://www.sbeducation.info/downloads/sbfail.pdf

19. About half of new employer firms survive at least four years (an estimated one-third of nonemployer firms survive this period), and of the firms that closed, owners of about a third felt the firm was successful at closure.

Closure rates among the variables reveal that employers and firms with starting capital greater than $50,000 have low closure rates, and young owners and firms with no starting capital have high closure rates. Industry differences are also as expected with manufacturing having lower closure rates than service and retail trade firms. Not only do a large percentage of new businesses remain open for a reasonable time period, but of the ones that do close, many are successful at closure. About half of new employer firms and about a third of new non-employer firms survive at least four years, and of the closures, about a third are successful at closure.

20. Roughly the same numbers of firms start and close each year. The dynamic nature of business is referred to as "creative destruction," the process through which healthy, vibrant firms create innovations, often to the detriment of those that fail to innovate and stay competitive.

Conventional wisdom has had a negative view of the chances of success for a new business, but it is also true that many firms close for reasons other than failure. Two-thirds of new employer firms survive at least two years, and about half survive at least four. Owners of about one-third of firms that closed report that their firm was successful at closure. Major factors in a firm's remaining open include an ample supply of capital, the fact that a firm is large enough to have employees, the owner's education level, and the owner's reason for starting the firm in the first place, such as freedom for family life or wanting to be one's own boss.

Business survival also varies by industry and demographics. The industry with the highest 1992-1996 survival rate for firms owned by white non-Hispanics was oil and gas exploration, which had an 82 percent survival rate for the four-year period. African Americans were most successful in legal services (79 percent), and Hispanic and Asian Americans in health services (66 percent and 76 percent, respectively).

21. Phillips and Kirchhoff (1989) mentioned the myth of 9 out of 10 new businesses closing in their first year. But using Dun & Bradstreet data they found that 76 percent of new firms were open after two years, 47 percent after four years and 38 percent after six years. These rates are substantially different than what is still commonly believed; more than ten years after the publication of their article, individuals still call the U.S. Small Business Administration looking for the unknown source of the alarming sound byte that 9 out of 10 businesses close in their first year. This myth may still exist because of the problems Williams (1993) details in using Dun & Bradstreet as a data source for business survival.

Even with the different data sources and time periods, survival rates seemed consistent. Although the business survival rates presented here simply confirm previous findings, perhaps this kind of independent confirmation is what is needed to dispel the myth that 9 out of 10 businesses close in their first year.

This paper analyzed business survival and the success status of closed businesses. As shown in Figure 1, BITS showed that about half of new businesses remained open for a reasonable time period and the CBO showed that about a third of all closed businesses closed while successful. Contrary to what is commonly believed, not all closures are failures. Only one-third of new businesses (33 percent) closed under circumstances that owners considered unsuccessful.http://www.sba.gov/advo/stats/bh_sbe03.pdf

22. There are substantial national consequences for differences in entrepreneurial activity. To start with, across the GEM countries about 300 million are involved in trying to start almost 200 million new firms. Another 57 million are the owner-managers of 37 million established firms attempting innovation and growth. This is accompanied by about US$360 billion of informal investments and US$32 billion in venture capital investments in new ventures. As a global phenomenon, entrepreneurial activity absorbs a substantial amount of human and financial resources.

People get involved in starting new firms for a number of reasons. One of the most basic distinctions is between those who seek to take advantage of unique business opportunities and those who cannot find suitable work and start a business to survive. The first may be considered "opportunity entrepreneurs" and the second "necessity entrepreneurs." They were identified across all GEM countries beginning in 2001.

Not only do these not exist world wide, they don't really exist for most countries. You could find some data for the US on the SBA, Office of Advocacy website, look for business statistics.

World wide, there are about 300 million persons trying to start about 150 million businesses. About one third will be launched, so you can assume 50 million new firm births per year. Or about 137,000 per day. As firm birth and death rates are about equal, the same number of active firms, say 120,000 probably terminate trading each day--world wide.

Total human population of 40 GEM countries is almost 4 billion out of a world population of 6.3 billion; 10 63% of the world population is represented in this assessment. Among these 4 billion, 2.4 billion are in the age range of 18-64 years, which approximates the working years in most countries. Among this 2.4 billion, about 12% or 297 million are active in trying to get 192 million businesses past the initial launch and through the initial three years of operation.

The country variation is substantial, from the 19 thousand people in Iceland trying to establish about 8,000 businesses to 107 million in India trying to establish 85 million businesses. The countries in Table 6 are rank-ordered by the total number of persons active in entrepreneurship, so some large countries with low prevalence rates-such as Russia-may be higher on the list than expected and some small countries with high rates of activity-such as New Zealand-may be lower on the list.

The adult population survey inquires about any ownership of an existing business. By adjusting for the size of the ownership group it is possible to estimate the total number of active businesses in each country. The total for the 40 GEM countries is about 347 million, from 15 thousand in Iceland to 142 million in China.11 Using the same procedures, the number of existing firms that may be considered entrepreneurial can be estimated at 37 million for all 40 countries, from 1,000 in Iceland to 19 million in China. While these estimates could be off as much as 20-30%, they have the advantage of being standardized across a wide range of countries at different levels of development.

Extrapolation to the other 37% of the world population not covered by GEM assessments, most in developing countries, would suggest a total of 472 million nascent entrepreneurs are trying to start 305 million firms; another 89 million owner-managers of 58 million existing businesses are emphasizing an entrepreneurial focus.